Fall 2013

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Market Overview

Even Ben Bernanke, who has extraordinary powers as Chairman of the Federal Reserve, does not have enough power to make our elected representatives in Washington earn their salaries and make the government run. We are now entering the second week of the government shutdown. In September, Ben surprised a majority of investors by not “tapering”, or beginning to remove stimulus from the economy. Although many thought the economy was not strong enough for the taper, most thought Ben had laid out his path of tapering and would stick to the plan nonetheless. Accordingly, investors were expecting the government to decrease its influence over keeping interest rates low. Then Ben surprised everyone and did not taper. It turns out, Ben saw the looming government crisis and apparently thought it was too risky to remove stimulus from the economy in the face of the government shutdown and looming debt ceiling debate.

What’s scary is that currently the government budget debate is probably not even close to the importance of the upcoming debt ceiling debate. The U.S. government is faced with what would be its first ever default on October 17. Now both parties have said there will be no default, but a couple of months ago, few thought we would be watching both sides of Washington bicker back and forth as hundreds of thousands of employees are furloughed and do not know when they will receive their next paycheck.

The stock and bond markets have been quite resilient however during the shutdown so far. This is mostly due to optimism that it will not last long, and that the government will most likely kick the can down the road again. It is interesting to note that history suggests that stock’s reaction to a shutdown is rather apathetic. Since 1980 there have been 11 shutdowns, averaging 4 days. The most recent was in 1995 and was the longest, lasting 21 days. It’s interesting to note that all shutdowns have occurred in the fourth quarter. Surprisingly, the S&P 500 gained 1.3% on average the week after the shutdown, and one month after the shutdown the S&P 500 was positive 9 out of 11 times with an average gain of 2.5%. So historically, shutdowns have mostly been a side show with little effect on the markets. However, this time could be different given that the potentially bigger issue of a U.S. debt default has not been debated yet.

Housing continues to see a mixed bag of results as interest rates dropped from their highs in September which was good news for home sellers and buyers. However, demand has diminished and inventory is still very low. With stricter regulations around debt to income ratios for potential home buyers set to begin in January, the housing market will need lower rates for a while in order for the housing market to adapt to the new standards. There are even stories circling around about how buyers have not been able to close because underwriters cannot receive required documents from the IRS because of the shutdown.

After several months of lagging performance, international and emerging stocks performed well - up more than twice the U.S. stock markets. If Europe and emerging markets can continue to perform well, that would be a good indicator for the global markets heading into the fourth quarter. But if the U.S. government shutdown continues, the fourth quarter could be painful for investors with no safe place to hide.

2013 Outlook Update

Below are a few bullet points from our outlook for 2013. Overall, they have not changed much from the prior newsletter, but we have added a few additional comments.

  • Ben Bernanke has continued to backstop the equity markets, as evident by the decision to continue the high level of stimulus to maintain low interest rates. The printing of easy money will continue, but it will begin to tamper most likely once Congress gets passed the debt ceiling debate. Bernanke has said he is willing to take his foot off the gas pedal (i.e. less stimulus), but he is not ready to apply the brakes (i.e. raising of interest rates by the Fed).

  • U.S. GDP has continued to stall around 2% into 2013 which means unemployment will not drop significantly. When the job market begins to gain steam, we would actually look for an increase in the unemployment rate as prospective employees reenter the market.

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Disclosures: This commentary is submitted for the general information of Cornerstone Wealth Management, LLC clients and may not be distributed to other individuals. This commentary is not deemed to be investment advice and information contained herein may not be current. An investor should consider the investment objectives, risks, charges, and expenses of each investment carefully before investing. For more complete information, you may contact us at 858-676-1000. Past performance is no guarantee of future results. Individual performance may vary and investment performance numbers may not be audited.